What insurers should consider when absorbing assets in a pension risk transfer
Edward Root, managing director & head of the Annuity Purchase Group, at Willis Towers Watson examines the differences between insurer and pension scheme investment strategies and the impact these can have on buy-ins and buyouts
Insurance Investor Editorposted on Thursday, October 31, 2019
Insurance Investor: Pension portfolios are made up of many different types of assets as their investment policies were created with a different risk measurement in mind.
As these portfolios transition to insurance general account assets, what is involved in the transition process for an insurer to restructure these inherited pension assets into a long-term asset liability matching insurance portfolio?
Edward Root: One nuance here is that deals that transact under $200 million tend to be mostly in the general account at an insurance company. Deals greater than $200 million tend to be mostly in a separate account at the insurance company.
On the smaller side, most transactions are paid in cash. When you get greater than $200 million, they tend to be paid in asset-in-kind (AIK) transfer.
Most of the time, when you have an AIK transfer from a plan sponsor to an insurance company, these assets are made up of investment grade corporate bonds. This is something that is readily available in pension plans right now.
Even though the insurance company will take most of these bonds, when you complete a deal, you don’t necessarily
get 100 per cent. So, if you are doing a $500 million deal, you won’t get 100 per cent AIK, but more so $300-$400 million, with the rest in cash.
"The big difference is that the insurance companies, as a group, tend to have a third of their ultimate portfolio in illiquid fixed income"
The insurance companies have a different mandate on what they are going to invest in. The big difference is that the insurance companies, as a group, tend to have a third of their ultimate portfolio in illiquid fixed income.
Insurance companies were doing LDI before they came up with the term LDI.
This one third that they are going to move or transition into, will be made of illiquid fixed income, mostly private placements, mortgages, agricultural loans, etc.
This is because there is really no run on the insurance company. They are holding for the long-term, so they are fine with having this illiquidity in order to get that extra yield.
They have very large investment departments and have experts who are very well versed in these types of fixed income assets.
II: How do insurers typically oversee this transition process? Do they have the in-house expertise to restructure the portfolios or do they rely on third party providers who can bridge that gap with the assets that the insurer does not trade on a daily basis?
Ed: You have to be careful about what you say in regards to the market, because there are about 600-700 transactions a year.
Numbers wise, most of these are deals that are less than $10 million. All of these sized deals will be done in cash, with no type of outsourcing or transition manager.
Once you start to get above $500 million, this is where you start to sometimes see transition managers on the portfolios.
"There are certainly particular situations where outsourcing could make sense."
Again, once the AIK is transferred over to the insurance company, they typically do not outsource investment management on this.
Out of the 16 insurance companies, there are a couple who do have some type of outsourcing, but the rest have all in-house investment departments.
When it comes to outsourcing, from servicing participant administration, it can depend. The kind of situations where I could see it making sense is if you were a new player in the market and didn’t have a good platform or call centre readily available. In such a case, it could make a lot of sense to outsource.
Or, if you had an older system and were thinking of updating it – and I can speak first hand on this - it may make sense to save the time and trouble to outsource this. There are certainly particular situations where outsourcing could make sense.
This excerpt was taken from the research report Insurance Asset Management, North America 2019. You can download the full report https://www.clearpathanalysis.com/reports/insurance-asset-management-north-america-2019.